Residual income, economic value added.
Intervilles SA operates two divisions, a Lorry Rental Division that rents to individuals and a Transportation Division that transports goods from one city to another. Results reported for the last year are as follows:
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Lorry Rental Division
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TransportationDivision
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Total assets
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€650 000
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€950 000
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Current liabilities
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120 000
|
200 000
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Operating profit before tax
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75 000
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160 000
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Required
1. Calculate the residual income for each division using operating profit before tax and investment equal to total assets minus current liabilities. The required rate of return on investments is 12%.
2. The company has two sources of funds: long-term debt with a market value of €900 000 at an interest rate of 10% and equity capital with a market value of €600 000 at a cost of equity of 15%. Intervilles' income tax rate is 40%. Intervilles applies the same weighted- average cost of capital to both divisions, since each division faces similar risks. Calculate the economic value added (EVA) for each division.
3. Using your answers to requirements 1 and 2, what would you conclude about the performance of each division? Explain briefly.